This Week In Securities Litigation (The week ending January 16, 2015)
The Commission brought cases related to HFT this week, but not against those traders. One action involved the operations of one of the largest dark pools. A second involved two exchanges. Each action involved specific types of orders which gave advantages to select groups of traders who were familiar with the trading systems and specifications of but not all market participants. The SEC also brought actions centered on market manipulation, conflicts and the misappropriation of assets.
SEC
Remarks: Commissioner Daniel M. Gallagher addressed the Women in Housing & Finance Public Policy Luncheon, delivering remarks titled Can the U.S. Be an International Financial Center? Washington, D.C. (Jan. 13, 2014). His remarks focused on the impact of regulation on the position of the U.S. capital markets in the world (here)
Rules: The Commission adopted rules to increase the transparency in the security-based swap market (here).
Exam program: The SEC announced the 2015 examination priorities (here).
Market committee: The Commission announced the members of its New Equity Market Structure Advisory Committee (here).
SEC Enforcement – Filed and Settled Actions
Statistics: During this period the SEC filed 2 civil injunctive action and 7 administrative proceedings, excluding 12j and tag-along-actions.
Dark pools/disclosure: In the Matter of UBS Securities LLC, Adm. Proc. File No. 3-16338 (Jan. 15, 2015) is a proceeding focused on the operation of UBS owned UBS ATS, an alternative trading system known as a dark pool. Between 2008 and 2011 the ATS executed hundreds of millions of sub-penny orders in violation of Reg. NMS, Rule 612. Many of the orders were the product of two order types which permitted the subscriber to gain priority in execution. This was not disclosed by the ATS. The pool, which is one of the largest, also did not disclose the fact that subscribers could prevent their order flow from executing in the venue against certain orders, largely those of market makers and high frequency traders. The feature was available only for those who used the UBS trading algorithms. There was no internal policy requiring the disclosure of the feature or the new order types to all subscribers. The Order alleges violations of Securities Act Section 17(a)(2), Exchange Act Section 17(a) and a series of rules along with Regulation ATS and Rule 612 of Regulation NMS. UBS resolve the proceeding, consenting to the entry of an order based on the Sections and Rules cited and to a censure. The firm also agreed to pay disgorgement of $2,240,702.50, prejudgment interest and a penalty of $12 million.
Microcap fraud: In the Matter of John Briner, Esq., Adm. Proc. File No. 3-16339 (Jan. 15, 2015) is a proceeding naming as Respondents Mr. Briner and Diane Balmy, both attorneys; two audit firms, De Joya Griffith, LLC and M&K CPAs, PLLC, and seven CPAs affiliated with the firms – Arthur De Joya, Jason Griffith, Chris Whetman, Philip Zhang, Matt Manis, Jon Ridenour and Ben Ortego. The action is an out-growth of stop order proceeding brought last year by the Commission relating to twenty sham offerings for mining companies. The scheme was orchestrated by barred attorney, John Briner, who recruited figureheads Stuart Carnie, Charles Irizarry, and Wayne Middleton to pose as the heads of the entities. Messrs. Carnie, Irizarry and Middleton settled in separate proceedings as noted below. Each of the offerings was alleged to be a sham. The audit firms and their auditors claimed to have audited the financial statements of the firms when in fact they did not. The Order alleges violations of Securities Act Section 17(a) by the attorneys and unprofessional conduct by the audit firms and auditors. The proceeding will be set for hearing. See also In the Matter of Wayne Middleton, Adm. Proc. File No. 3-16342 (Jan. 15, 2015); In the Matter of Charles Irizarry, Adm. Proc. File No. 3-16341 (Jan. 15, 2015); and In the Matter of Stuart Cranie, Adm. Proc. File No. 3-16340 (Jan. 15, 2015). These actions center on claims that the named Respondent served as a figurehead for the corporations at the behest of Mr. Briner. Each alleged violations of Securities Act Section 17(a). In each the Respondent settled, consenting to the entry of a cease and desist order and agreed to pay disgorgement, prejudgment interest and a penalty. Each Respondent also agreed to the entry of an order barring him from serving as an officer or director and from participating in any penny stock offering. Mr. Middleton will pay disgorgement of $4,000, prejudgment interest and a penalty of $8,000; Mr. Irizarry will pay disgorgement of $6,000, prejudgment interest and a penalty of $12,000; and Mr. Carnie will pay disgorgement of $6,000, prejudgment interest and a penalty of $12,000.
Manipulation: SEC v. Milrud, Civil Action No. 2:15-cv-00237 (D. N.J. Filed Jan. 13, 2015) and U.S. v. Milrud, Mag. No. 15-7001 (D.N.J. Jan. 13, 2015) are actions for market manipulation against Aleksandr Milrud, a Canadian citizen resident in Ontario and Florida. The scheme began in 2013 when Mr. Milrud recruited groups of online traders based primarily in China and Korea. He used these traders to engage in a spoofing scheme. The scheme centered on placing trades in a “dirty” account which were canceled when the price started to move as a result of increased interest in the stock from the orders. The price movement was then captured by placing trades on the other side through a separate “clean” account. The scheme came to light when Mr. Milrud demonstrated it to a broker he was recruiting. A broker is now a confidential witness. The SEC’s complaint alleges violations of: Securities Act Section 17(a) and (c); Exchange Act Section 10(b) and Rule 10b-5(a) and (c); Exchange Act Section 9(a)(2); and control person liability under Exchange Act Section 20(b) along with joint and several liability under Section 20(a). The cases are pending.
Order types: In the Matter of Edga Exchange, Inc., Adm. Proc. File No. 3-16332 (Jan. 12, 2015). Respondents Edga Exchange, Inc. and Edgx Exchange, Inc. are currently registered with the Commission as national securities exchanges under Section 6(a) of the Exchange Act. The exchanges were acquired by BATS Global Markets in 2013 as part of the acquisition of Direct Edge. Prior to their 2009 application to become exchanges, Edga and Edgx were ECNs. ECNs and exchanges offer different categories of order types, including those which are displayed and not displayed or hidden. The access rule, Rule 610 of Regulation NMS, requires that exchanges establish rules requiring members to avoid displaying quotations that lock or cross any protected quotation in a NMS stock. A crossed market exists when a protected bid price exceeds the protected offer price. A locked market exists when a protected bid price is identical to a protected offer price. Under the access rule the Direct Edge ECNs developed an order handling procedure known as price sliding for non-routable orders – those that had to be executed in that venue – that would otherwise lock or cross a protected quotation, a National Best Bid or Offer. After the rules were developed the exchanges crafted alternatives to the price sliding functionality. When certain high speed traders requested a modification, the exchanges created it. Additional changes were made. The modifications were disclosed to all traders. They also were not reflected in rules approved by the Commission. The Order alleges violations of Exchange Act Sections 19(b) and (g). To resolve the action each Respondent consented to the entry of a cease and desist order based on the Sections cited in the Order, to the entry of a censure and to jointly and severally pay a $14 million penalty.
Misappropriation: SEC v. Thibeault, Civil Action No 1:15-cv-10050 (D. Mass. Filed Jan. 9, 2015). The action names as defendants: Daniel Thibeault, President, primary owner and CEO of defendant Graduate Leverage, LLC; Graduate Leverage, founded by Mr. Thibeault in 2003, operates multiple investment and financial businesses; GL Capital Partners LLC is a registered investment adviser primarily owned by Graduate Leverage; GL Investment Services, LLC is a registered investment adviser whose sole member is Graduate Leverage; and Taft Financial Services, LLC which is “nominally” run by Eric Kratzer but on “information and belief” is controlled by Mr. Thibeault. The GL Beyond Income Fund was created by Mr. Thibeault in 2012. He served as the portfolio manager or co-manager. It is a closed end management company which purchases consumer loans. The Fund’s daily valuation report for December 8, 2014 lists about $35.65 million in consumer loans. It also claims to hold about $385,000 in U.S. equities and $6.55 million in promissory notes issued from the Fund to an entity named LAOH Capital LLC. The fund listed its total assets as of December 8, 2014 as $423.585 million. In early 2013, Mr. Thibeault initiated a scheme to use the Fund’s money to support his faltering financial advisory business. Fictitious loans were created with the proceedings being transferred to Taft Financial which then forwarded the funds to Graduate Leverage. An inspection by the Commission staff determined that a significant number of promissory notes were missing and there were flaws in others. Following the inspection the FBI executed a search warrant at the offices of the defendants. The complaint alleges violations of Exchange Act Section 10(b), Securities Act Section 17(a) and Advisers Act Sections 206(1) and (2). Requests for freeze orders and other relief are pending. See Lit. Rel. No. 23171 (Jan. 9, 2015).
Conflicts: In the Matter of Shelton Financial Group, Inc., Adm. Proc. File No. 3-16334 (Jan. 13, 2015) names as Respondents the registered investment adviser and its founder, Jeffrey Shelton. The Order alleges that the firm had an arrangement with a broker under which it was paid for all client assets that were invested in certain mutual funds. The broker, in return, obtained certain custodial support services. Initially the arrangement was not disclosed. Later it was partially disclosed. While eventually the conflicts were disclosed the initial failure violated Advisers Act Sections 206(2) and 207 as well as 206(4), according to the Order. To resolve the matter the defendants consented to the entry of a cease and desist order based on the Sections cited in the Order and to a censure. In addition, the Respondents will, on a joint and several basis, pay disgorgement of $99,114,19, prejudgment interest and a penalty of $70,000.
Criminal cases
Investment fund fraud: U.S. v Duffy, Case No. 1:09-cr-00709 (S.D.N.Y.) is an action in which the former chief compliance officer of WG Trading Company, LP, Deborah Duffy was sentenced to time served in prison for conspiracy, securities fraud and money laundering. Ms. Duffy maintained the books and records for WG Trading, a fraudulent commodities trading and investment advisory scheme conducted by Stephen Walsh and Paul Greenwood from 1996 through early 2009. The scheme raised billions of dollars, much of which was misappropriated. Ms. Duffy previously pleaded guilty. She cooperated with the government which is reflected in her sentence.
FINRA
Fraud/suitability: A hearing panel expelled John Carris Investments, LLC and barred CEO George Carris from the securities industry for recklessly selling shares of stock and promissory notes issued by the firm’s parent based on misleading and incomplete statements. Andrey Tkatchenko, a registered representative, was suspended for two years and fined $10,000 for recommending the stock and notes without a reasonable basis. The firm and Mr. Carris were also expelled and barred for manipulating the share price of Fibrocell stock. Head trader Jason Barter was suspended for 18 months and fined $5,000 in connection with those transactions. The panel also found a series of other violations including operating without sufficient capital, inaccurate books and records, failing to remit payroll taxes, failing to implement the AML system and not enforcing supervisory systems.
Fair trade: A FINRA hearing panel determined that John Thomas Financial and its chairman, Tommy Belesis, violated principles of fair trade in connection with the sale of a block of American West Resources, Inc. stock. Specifically, while the firm sold a block of stock as the price spiked, customers were unable to sell their shares. The panel also found that Mr. Belesis and CCO Joseph Casstellano intimidated registered representatives. Mr. Belesis, in addition, lied to the regulator. Fraud and other charges were dismissed. Mr. Belesis and the firm were suspended for two years and jointly and severally fined $100,000. Mr. Castellano was suspended for one year and fined $50,000. The panel also found that the firm failed to keep required records and rejected as not credible testimony by Mr. Belesis that he was unfamiliar with the record keeping requirements.
Hong Kong
Concealed losses: The Securities and Futures Commission barred Jagjit Singh Dhillon, formerly of Credit Suisse Securities (Hong Kong), for life for concealing certain trading loses in two trading books for which he was responsible The losses, suffered in May 2012, caused the firm to have to make negative adjustments of U.S. $4 million to the cumulative monthly profit and loss figures for its trading book and recalculate the risk exposure recorded in its risk management systems.